AES Case Final
AES Case Final
AES Case Final
BUDGETING
Globalizing the Cost of Capital and Capital Budgeting at
AES, Harvard Case 5-206-080
TABLE OF CONTENT
Description of the case
The Venerus methodology
Our mitigations
A NEW METHODOLOGY
Description
Lal Pir Project
Considerations on the methodology
DESCRIPTION
Step
Required Information
Risk-free rate
3. Calculate cost of equity for each
AES business
Risk-free rate
4. Calculate the cost of debt
Default spread
Approach
Unlever and average equity betas for
comparables in each AES line of
business
BETA ESTIMATION
0,25
Large Utility
0,25
Growth Distribution
0,25
Competitive Supply
0,50
BETA ESTIMATION
Step
Required Information
Approach
Unlever and average equity betas for
comparables in each AES line of
business
Contract Generation
Large Utility
Growth Distribution
Competitive Supply
0,25
0,25
0,25
0,50
COST OF EQUITY
Step
Required Information
Approach
Target capitalization
ratios
Estimated by project
using cash flows to
calculate desired EBIT
coverage
Levered
Unlevered
D/V
35,10%
E/V
64,90%
Tax Rate
23,00%
Levered
Step
Required Information
3. Calculate cost of
equity for each AES
business
0,39
Cost of Equity
(Ke)
Approach
0,25
Rf
4,50%
MRP
7,00%
Levered
Ke
0,39
7,20%
COST OF DEBT
Step
Required Information
Approach
Risk-free rate
Default spread
Cost of Debt
(Kd)
Rf
4,50%
Default
Spread
3,57%
Kd
8,07%
Required Information
4,50%
0,39
MRP
7,00%
Ke
7,20%
Country Risk
9,90%
Adjusted Ke
Approach
The difference between local
government dollar-denominated bond
yields and the corresponding U.S.
Treasury Note
17,10%
Rf
4,50%
Default Spread
3,57%
Kd
8,07%
Country Risk
9,90%
Adjusted Kd
17,97%
BUSINESS RISK
Categories of Risk
Weight
Operational / Technical
3,50%
0,035
Counterparty Credit /
Performance
7,00%
0,070
Regulatory
10,50%
0,210
Construction
14,50%
0,000
Commodity
18,00%
0,180
Currency
21,50%
0,430
25,00%
0,500
1,425
Contractual
Enforcement / Legal
Sum of individual
scores = business
specific risk score
Adjustment to
WACC: 712,5 bp.
4,50%
Levered
0,39
MRP
7,00%
Ke
7,20%
Country Risk
9,90%
Adjusted Ke
17,10%
Rf
4,50%
Default Spread
3,57%
Kd
8,07%
Country Risk
9,90%
Adjusted Kd
17,97%
Business Risk
Adjustment to WACC
Adj. WACC
17,10%
64,90%
17,97%
35,10%
15,95%
1,425
7,125%
23,08%
Cost of Equity
12,00%
Terminal Value
0,0
Explicit Horizon
179,6
Equity Value
179,6
Growth
0,0%
Cost of Capital
23,08%
Terminal Value
0,0
Explicit Horizon
276,6
Enterprise Value
276,6
430,7
0,0
-154,0
MITIGATIONS
New methodology results
Ke y i n t e rro g a t i o n s
Suggested alternatives
Country
Line of
Business
Sovereign
Spread
Cost of
Equity (Ke)
Cost of Debt
(Kd)
Business
Risk
Cost of
Capital
(WACC)
Red Oak
USA
CG
0,00%
7,39%
8,07%
3,20%
9,66%
Ottana
Italy
CS
0,14%
10,73%
8,98%
2,13%
10,77%
Gener
Chile
CG
1,73%
8,93%
10,57%
3,75%
12,63%
Kelvin
South Africa
CG
3,14%
10,25%
11,98%
5,35%
15,18%
Drax
United
Kingdom
CS
0,00%
9,46%
8,07%
7,30%
16,35%
Haripur
Bangladesh
CG
5,23%
12,35%
14,07%
3,95%
16,88%
OPGC
India
CG
3,60%
10,61%
11,67%
7,45%
18,11%
Rivnoblenergo
Ukraine
GD
9,98%
17,24%
18,05%
3,03%
18,58%
Lal Pir
Pakistan
CG
9,90%
17,10%
17,97%
7,13%
23,08%
Uruguaiana
Brazil
CG
8,93%
16,01%
15,28%
11,05%
25,15%
Eletropaulo
Brazil
LU
8,93%
15,93%
16,32%
10,88%
25,26%
Los Mina
Dominican
Republic
CG
8,93%
15,88%
15,28%
12,83%
27,44%
Telasi
Georgia
GD
9,98%
16,85%
16,33%
12,65%
28,51%
Andres
Dominican
Republic
CG
8,93%
16,13%
17,00%
15,00%
29,94%
Caracoles
Argentina
CS
16,25%
26,66%
24,32%
9,13%
31,36%
KEY INTERROGATIONS
Beta based only on US comparables
Business risk discrepancies:
The UK plant has a higher business risk than Lar Pir in
Pakistan, than Haripur in Bangladesh
Project-specific spread is linear
SUGGESTED ALTERNATIVES
THE SOVEREIGN RISK PREMIUM (1/2)
Methodology:
Sovereign premium based on
ratings
Measure of the default risk of
country
Issues:
certain lag in comparison to
markets when it comes to
responding to changes in the
default risk
Rating agencies focus more on
default risk : understatement of
the equity risk premiums
SUGGESTED ALTERNATIVES
THE SOVEREIGN RISK PREMIUM (2/2)
Sovereign Risk
Currency Risk
Banking Sector Risk
Political Risk
Economic Structure Risk
Overall Country Risk
SUGGESTED ALTERNATIVES
THE BETA ESTIMATION (1/2)
Separate developed and strong emerging
economies
Find local comparables
SUGGESTED ALTERNATIVES
THE BUSINESS-SPECIFIC RISK
Weights allocation?
Subjective
Should they be the same for each project?
CONCLUSION
No consensus to have the best risk estimation
Accuracy and relevance improvement suggested